What is it called when one party agrees to purchase goods and services with a specified percentage of the proceeds from the original sale?

When buying goods for your company, should you use a purchase order or a purchase agreement? To determine this, you need to understand the differences between these two commercial purchasing documents.

Purchase orders and purchase agreements are both legal documents used in the purchase of goods. A purchase agreement is also used in real estate transactions. The document used to purchase services is more often called a contract or service agreement.

Although a purchase order, or PO, and a purchase agreement are both used to make purchases, they operate in different ways. Understanding the differences will help you determine which to use for your business transactions.

Contract Basics

To understand purchase orders and purchase agreements, it is first necessary to have a basic knowledge of how a contract is created. For purposes of this discussion, the example will be used of a buyer seeking to purchase goods from a seller.

A contract is formed when the buyer makes an offer to purchase the goods, and the seller accepts that offer. The seller must accept the offer on the terms contained in the offer. If the seller changes any of the terms, it is not an acceptance. Rather, the proposed change in terms makes it a counteroffer by the seller, which the buyer must then accept in order to create a contract.

Of course, contract law is much more complex than what is explained by this example. However, this simplification of contract law will be sufficient for the purposes of explaining the difference between a purchase order and a purchase agreement. The main difference between the two documents is how and when they become a binding contract.

Purchase Orders

A purchase order is an offer to purchase goods. It is created by the prospective buyer and sent to the prospective seller. At the point the PO is sent, it is not a contract. There are two ways that a purchase order becomes a contract:

• One way is if the seller accepts the terms of the purchase order by signing the PO or otherwise expressing acceptance in writing.
• The other way is by the seller's providing the ordered goods.

At a minimum, the PO will contain the names of the buyer and seller, a description of the goods being ordered, and the price to be paid. It also may include various other terms, which can make it as detailed as a purchase agreement. Communication of a PO was traditionally done by mail or fax, but now is frequently done online. Such electronic transmission can be done via email or at the seller's website.

Purchase Agreements

A purchase agreement is a legal document that is signed by both the buyer and the seller. Once it is signed by both parties, it is a legally binding contract. The seller can only accept the offer by signing the document, not by just providing the goods.

A PO is created before there is an agreement between the parties: The buyer sends the PO to the seller, who then has the choice of whether to accept it. With a purchase agreement, the parties have worked out their agreement beforehand, and the purchase agreement is the written expression of that agreement.

A purchase agreement will contain all of the information that would be in a PO, but is often a longer document that contains additional details.

When to Use a PO and When to Use a Purchase Agreement

There are no rules about when either type of document must be used. Whether a PO or a purchase agreement is used will depend upon the nature of the purchase or the customary practice of the industry. For example, real estate transactions are conducted with a purchase agreement, not with a PO. Also, if a government contract is involved, the rules or policies of the government agency may dictate the type of document to be used.

If repeated purchases or deliveries will be made over time, a mix of documents can be used. Sometimes both documents are used, with the purchase agreement stating the comprehensive terms of the agreement and POs being used to request deliveries as needed.

Other times, a "blanket" purchase order is used that states the complete terms, and other documents—often called releases or calls—are used by the buyer to schedule the specific deliveries. Such an arrangement to supply the buyer's continuing needs is sometimes created by a product supply agreement.

A purchase order is more often used when the purchase is relatively simple, or when there will be repeated purchases of the same type of goods. For example, purchasing office supplies, a laptop computer, or other items used on a regular basis usually will be done with a PO.

Purchase agreements are generally used when the transaction is more complex, or when the goods are more expensive. For example, a purchase agreement is more likely for buying a $100,000 piece of machinery that requires the seller to set it up and provide support services. However, there is no clear-cut line between when either type of document will be used.

Regardless of whether a purchase order or purchase agreement is used, it is important to create a document that includes all of the desired terms of the agreement, and to understand when a binding contract is created.

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